You pay the Christmas bonuses. Then January hits, more job costs come in, and the profit you paid those bonuses on starts to shrink. In part nine of our construction accounting series, Kathe Barrington, CPA, of KB CPA walks through the year-end close and how to get numbers you can trust before you spend the money.
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Your Year-End Close Starts in January
Kathe goes out on a limb here. If you have a December year end, preparation starts in January.
You’ve built the SOPs for your month-end and quarter-end closes. Do those well and year end is, in her words, “a final audit and a cleanup and putting a bow on everything.”
A hard year-end close is telling you which SOPs need work. Plenty of contractors grind through it to stay out of tax trouble. Then they ignore what it told them and get the same headache twelve months later.
How Many Adjusting Entries Does Your CPA Firm Make?
When Kathe takes on a new client, she counts the journal entries the CPA firm sent back at year end. Her clients all get reviewed statements, so there are true-up entries for GAAP and more.
“My goal is to only have a tax adjustment at year end.”
If your outside firm makes a pile of adjustments every year, your numbers were off all year. You were making decisions on them anyway.
What to Have Ready for a Reviewed Statement
A reviewed statement means you’ll support nearly your whole balance sheet and your job schedule. That’s an intensive close. Your controller or CFO should be building that support before the CPA firm starts.
Check the Year-End WIP Schedule Against January Job Costs
How does Kathe test a year-end WIP schedule? She looks at the job costs landing in the new year.
Say you close a batch of jobs in December. In January she pulls those jobs up. If costs are still hitting them, she starts asking questions. Is there a cutoff problem? Is there an SOP problem? Why did we close a job that still has costs coming?
Some of her clients move the close from the 15th to the 20th to catch more of those costs. Others close tight. The tighter your cutoff, the more checking the numbers need.
Pending Change Orders, Job Losses and Profit Fade
Start with losses. “Job losses should always be taken as soon as you know them.” Year end doesn’t change that. You’re required to take the loss up front.
Pending change orders get a conservative lens. Eric asked Kathe to define that. If your jobs normally make 18 to 20 percent, don’t book 30 on a job with a bunch of pending items.
Take too much profit now and it fades later. “You’re going to start off your year with a hole.” You open the new fiscal year at zero and you’re already taking losses.
What about jobs still underway? When you’re in doubt, put a little more cushion in the job.
Don’t Close Jobs Too Early
The biggest problem Kathe runs into the following year is closed job costs. The job gets closed and the costs keep coming. Or somebody puts a change order on it and the job has to be reopened.
Ask yourself one question. Am I 100 percent confident this job is done and no more work is coming?
“It’s better to leave it open than to be aggressive in closing it out.”
If anything is pending on a job, she wouldn’t close it.
The Job That Took 11 Years to Close Out
Eric asked for the longest closeout she’s seen. Eleven years. The GC was a nightmare and wouldn’t close the jobs out, and they ended up in a lawsuit.
What did her client learn? Don’t work with that GC again. The type of work had nothing to do with it.
Some contractors go back to a bad GC or a bad owner anyway. Kathe’s view is that a job ending in a loss or a lawsuit tells you the risk is too high.
Payroll, Equipment and Overhead at Year End
Payroll rarely gets missed because it’s so time sensitive. Fixed assets might need cleanup, like equipment you scrapped and never took off the books. It’s usually zero value by then.
The damage comes from missed costs that land in the following year.
Book Profit vs. Taxable Income
Larger contractors have to use accrual and percentage of completion for tax. Kathe puts that line at about $32 million. For them, the books usually sit close to the tax basis.
Smaller contractors may be cash basis or completed contract for tax. Close a job early there and the entire profit lands on this year’s return.
So run a projection. What happens if all of these jobs close? Then sit down with your tax person. Kathe doesn’t do taxes. She works closely with the people who do.
What Your Bank and Surety Will Question
Your bank and bonding company see your internal financials first. The reviewed statement shows up about three months later.
“You don’t want changes from your internal statement that you can’t fully explain.”
Say the two are far apart and your answer is that you had a ton of adjustments. Nobody is going to trust your internal numbers after that.
What to Do in October
Here’s Kathe’s list for right now.
Get your Q3 numbers as close as you can.
Decide which jobs you expect to close by December 31.
Extrapolate through year end and take that to your tax person. Do you buy the excavator this year? Do you pay off the line of credit? Where do you need cash?
Do this in October and November. December 15 is too late. “Don’t make it a fire drill for them.”
And bonuses usually go out in December. Kathe has seen contractors pay a bunch of bonuses and then take a bunch of hits at year end.
So get a meeting on the calendar this week with your accounting lead and your project managers. Go through Q3 and every job you expect to close. Ask what costs could still come in and which change orders are unresolved.
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The Full Construction Accounting Series With Kathe Barrington
Start at the beginning or jump to what you need. Watch the whole series in one place on the Construction Accounting Series playlist: https://www.youtube.com/playlist?list=PLNqgaQ0mEF1w
- WIP Reports Made Simple: The Key to Stopping Hidden Job Losses (Ep. 357): https://www.constructiongenius.com/wip-reports-made-simple-the-key-to-stopping-hidden-job-losses-ep.-357
- How to Use Your WIP to Protect Cash and Grow Profitability (Ep. 359): https://www.constructiongenius.com/how-to-use-your-wip-to-protect-cash-and-grow-profitability-ep.-359
- Physical Progress vs. Financial Reporting in Construction Projects (Ep. 364): https://www.constructiongenius.com/physical-progress-vs.-financial-reporting-in-construction-projects-ep.-364
- Underbillings Bad. Overbillings Better: The Cash Flow Truth Construction Owners Can’t Ignore (Ep. 368): https://www.constructiongenius.com/underbillings-bad-overbillings-better-the-cash-flow-truth-construction-owners-cant-ignore-ep.-368
- Why Your Jobs Look More Profitable Than They Are: Indirect Allocations and Overhead in Construction (Ep. 377): https://www.constructiongenius.com/why-your-jobs-look-more-profitable-than-they-are-indirect-allocations-and-overhead-in-construction-ep.-377
- How to Read Your Backlog Like a Banker: Timing, Diversification, and Gross Profit Discipline (Ep. 388): https://www.constructiongenius.com/how-to-read-your-backlog-like-a-banker
- How to Grow Bonding Capacity: Banking and Tax Moves for Contractors (Ep. 396): https://constructiongenius.com/grow-bonding-capacity-banking-tax-moves-contractors/
- Projections: The Art and Science of Seeing Ahead (Ep. 400): https://www.constructiongenius.com/construction-projections-cash-flow-margin-kathe-barrington
About the Guest
Kathe Barrington is a CPA with 30+ years of accounting experience, 20 of them focused on construction. Through KB CPA, she works as a fractional accounting resource for commercial construction companies, GCs and specialty contractors, that don’t need a full-time CFO or controller but do need serious, construction-literate financial support. She works hourly with a full team behind her.
Connect with Kathe Barrington
LinkedIn: https://www.linkedin.com/in/kathe-barrington-a6346337
Facebook: https://www.facebook.com/p/Kathe-Barrington-CPA-100072271041746
KB CPA: https://kbcpa.biz
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